Doing your taxes is never fun. Even if you ignore how you must spend a couple hours filling out boring forms, finding documents, researching deductions, blah blah, there’s always the fear that you’ll be audited. I remember having the most vanilla tax returns back when I was a teenager, the 1040-EZ, and even then I was irrationally concerned about an audit.

The reality is that very few people get audited, just a percent or so each year (in 2010, 1.1% of returns were examined), and some of them deserve it. As much as we may like to think of the IRS as some cruel, emotionless monster trying to make the lives of hardworking Americans as miserable as possible, it’s not. They’re trying to collect tax revenue so the government can continue to provide the services hardworking Americans need.

How do they decide who to audit? It’s actually very straightforward.
In 2006, they published a page on the IRS.gov website that details exactly how they determined which tax returns to audit. It comes down to these four main ways (for individuals):

Computer Scoring – Tax returns are “scored” using two systems – Discriminant Function System (DIF) and Unreported Income DIF (UIDIF). The Discriminant Information Function System (DIF) score gives the IRS an indication of the potential for change in taxes due, based on past IRS experience. The Unreported Income DIF (UIDIF), as you can imagine, scores the return on the potential for unreported income. The higher the score, for either, the more likely the return will be reviewed.

Information Matching – This is an obvious reason because it’s the easiest to catch. The IRS receives the same W-2s and 1099s that you do, so it’s trivial for them to compare the two totals. If they don’t match, they investigate. Usually the investigation is simply a CP2000, rather than a full blown audit, because the problem is easy to catch and correct.

Related Examinations – Beware who your friends/business contacts are! If their returns are audited and their return includes transactions with you, your return may be audited as well. The reason this makes sense is because if their return has a problem, the correction may involve your return. You may not be audited but you may receive a request for clarification.

Potential participants in abusive tax avoidance transactions – The IRS may get information about promoters of and participants in various schemes and select a return for audit based on that information.

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There is accually an IRS code section to keep tax papers (the Code call them “books and records”) for as long as a potential tax liability may be relevant. So the best you can do in the case where records a get lost is to recreate another record the best you can, indicating the details of substance of the records lost and details of how those records got lost or destroyed. In the case of an audit, the first request will be for the substantiation of the position you took on your return, the next will be how did the record get destroyed, what did you do and when did you do it.

What exactly is done with your tax forms after the IRS receives them. Does the IRS run every form through a computer system to look for errors, or, are the forms reviewed by people. Does every form get reviewed in some way? I read that only 1 of 150 returns actually gets audited.
The reason I ask is because I have a friend who mentioned that he had received a letter from the IRS stating that he would get a larger refund since information about an earlier payment he had made had not been included on his return. That is what prompted my question. How are errors caught?

I don’t believe this at all. Just this year I was Audited for state return for 2010 and Federal for 2009. Every year since 1994 we have been audited. for something. Usually, they owe us. Other times I have to explain my tax info by phone and it is resolved in my favor. I feel we are bein harrassed. We use turbo tax every year.

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